1
The Development of Global Financial
CentresbyDatuk Seri Panglima Andrew L.T.
ShengTun Ismail Ali Professor of Monetary and
Financial EconomicsFaculty of Economics and
AdministrationUniversity of MalayaThe Puteri
Pacific Hotel, Johor BahruThursday, 18 May
2006
2
Contents

1. Role of Financial Centre in National and Global
   Context
2. How Hong Kong defended and enhanced position as
   largest international financial centre ex-Japan
3. Key issues in building IFCs
4. Potential for Malaysia

3
Cities and Financial Centres

• Efficiency of economies all about efficiency of
  urban centres, e.g. New York vs. Mexico City
• Cities are knowledge centres
• Art, culture, politics, trade, news
• Must have rich hinterland, linked by superior
  communications, e.g. river, sea, road, rail, air
• Exchanges and Technology
• Pre-telegraph, 100 US exchanges,
• Advent of radio, 22 (1935)
• Advent of computers - 7 (1995)

4
Financial Markets are Networks

• Metcalfes Law - The value of a network goes up
  as the square of the number of users
• Economies of Scale
• Supply side - Biggest producer wins
• Demand side - Biggest buyer determine standards
• Critical Mass
• Aggregation of local knowledge and skills
• Best combination of skills create economies of
  scale
• Critical Mass Clusters skills concentration
• Supply Chain Management - where in the chain is
  real value?

5
Changing Structure of Financial Markets

• Financial Innovation
• Evolution of derivatives, options futures
• Technology Telecommunications
• Global 24 hours markets
• From market place to market space
• Deregulation
• Lines of traditional businesses blurring

6
Finance is Derivative of Real Economy, Value
defined by information Knowledge

• Commoditization means that low-knowledge products
  and services have high competition, low prices
  and are easily duplicated and therefore taken
  away.
• Markets are all about branding and high
  knowledge content products. Knowledge content
  needs governance - value creation needs total
  inputs at production, design, packaging and
  marketing levels.
• Network Economy demonstrates winner-take-all
  situation. Financial markets converge on key
  hubs, e.g. New York taking American time zone
  business, London taking European time zone
  business

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Reliable InformationEssential for Quality of
Markets

• Quality Markets require real time and reliable
  information to make sound risk management
  decisions in highly volatile environment
• High quality information requires
• Good accounting and auditing standards
• Reliable timely statistics/reporting processes
• Infrastructure to process information for making
  decisions critical to competitive success
• Bad accounting distorted information poor
  decision making bad risk management
  ?
  financial crisis

8
Hierarchy of Information

• Robert W Lucky, Silicon Dreams Information, Man
  and Machine, St Martins Press, 1991.

9
Sequencing and Hierarchy of Domestic Financial
Markets

• Asset-backed
• securities and
• derivatives
• Corporate bond and
• equity markets
• Government bond market
• Treasury bill market and
• foreign exchange markets
• Money market

Source Karacadag, Sundrarajan Elliot, 2003
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Market DisciplineKey for Corporate Governance

• Quality of markets depends on quality of
  corporate governance in listed companies
• Corporate governance is about three key
  disciplines
• Self discipline - ethics fairness
• Regulatory discipline - a level playing field
• Market discipline - competition accountability
• Asia traditionally stressed first two disciplines
  at the expense of market discipline
• The key to capital market development is to
  promote and enforce these disciplines based on
  reliable information

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Efficient Markets require

• Free Entry of Participants and Products
• High degree of transparency/low information
  asymmetry
• Efficient Operations by solvent participants
  under international rules of the game at low
  transaction costs
• Absence of incentive distortions or bias that
  moves markets in unhealthy direction e.g. moral
  hazard or subsidies
• Efficient regulation at low regulatory costs
• Orderly exit of insolvent participants obsolete
  products and insolvent operators create huge dead
  costs on market
• ? Accountability feedback and exit for bad
  players

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Malaysia already has balanced financial sector(
of GDP)
Bank Deposits Bank Deposits Equity Market Equity Market Bond Market Bond Market
1990 2004 1990 2004 1990 2004
China 75.6 177.8 n.a. 40.3 8.5 29.4
Hong Kong 205.6 299.3 107.2 486.3 1.5 28.3
India 31.4 51.1 10.4 48.4 19.9 31.7
Indonesia 29.8 38.9 4.4 24.9 0.4 24.1
Japan 100.0 120.5 121.7 73.2 85.9 181.6
Korea 32.6 68.8 48.2 56.1 34.1 74.9
Malaysia 52.1 88.7 100.7 152.6 69.8 89.3
Singapore 74.3 104.4 95.8 149.0 27.8 58.6
Thailand 56.8 79.7 29.2 72.3 9.7 38.9

Germany 53.8 96.7 21.7 42.2 51.6 80.3
UK 87.8 115.0 85.2 123.0 36.8 43.9
US 59.6 58.8 57.5 131.6 122.0 157.2
Source World Bank Financial Sector Dataset,
February 2006
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Case Study Hong Kong as IFC after 1998 Stock
Market Intervention

• August 1998 HK Govt intervened with US15
  billion in stock market to stop hedge fund
  speculation
• Immediate action
• Rebuild Market Credibility
• Close Gaps with London/New York
• better regulation, more products, greater
  liquidity
• Build Stronger Links with China and Asia
• more research, better marketing, closer
  connections
• Medium and long-term
• Greater integration with Pearl River Delta to
  compete against Yangtze River Delta/Shanghai
• Wall Street in Asia

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Strengths of Hong Kong

• Low Transaction Costs
• Rule of law with advanced property rights system
• Free and open economy with world-class financial
  system
• Low tax rate and simple tax system
• Low Exchange Rate Risk and Uncertainty
• Fully convertible currency
• Exchange rate linked firmly to USD
• Fully open and deep capital market
• Next to Rapidly Growing Southern China
• Potential for lowering production costs
• Potential for expanding turnover
• Potential for servicing new wealth

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Understanding Strengths and Weaknesses

• Pre-WTO, Hong Kong had premium as external window
  for China and East Asia, when access to markets
  and knowledge was poor
• Franchise is eroding when China gains access to
  WTO and through Web
• However, biggest value added is Localization of
  Global Knowledge - add value by being
• Preferred financial centre in Asian Time Zone
• Best logistics centre in ATZ
• Importing external skills e.g. marketing,
  finance, technology and tailoring for local
  markets

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Learning from Competitors

• Lessons from Shanghai and Singapore
• Clear vision, sound strategy and detailed
  blueprint
• Effective coordination among local and central
  governments and business
• No economic borders to residents or outsiders
• Lessons from Japan, Taiwan and other Asian
  economies
• Political stability key to stable growth
• Protectionist policies only delay pain
• People and capital move faster than policy
  changes
• Implications for Hong Kong
• Economic and financial integration of Hong Kong
  (finance), Southern China (manufacturing) and
  Taiwan (technology).
• Hong Kong could provide the best service for
  Mainland, Taiwan, Asia and international business

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Competition Co-operation Strategies

• Hong Kong domestic market alone too small to have
  critical mass
• In areas where HK has critical mass, play
  dominant player strategy
• e.g. Financial services - improve quality to
  capture value in Supply chain management
• In areas where HK has no critical mass, cooperate
  and affiliate
• e.g. Move manufacturing where there is cheap
  labour
• e.g. cooperate with others to achieve economies
  of scale airports, power, environment

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Markets are a function of Liquidity Friction
Costs

• The greater the friction cost, the more the
  market moves to areas with lower friction costs
• The lower the friction cost, the higher liquidity
• Friction costs depend on the following-
• Time speed to market
• Factor costs Labour, Capital, Taxes
• Infrastructure costs - how good is physical
  utilities?
• Government costs - are rules policies costly?
  
• Barriers to Entry - competition policy

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Structural Costs Compared

• HKSAR China US Japan
• Production Costs High Low High High
• Transaction Costs Low High Low Medium
• Infrastructure Cost High Medium Low Medium
• Saving Rate Medium High Low High
• Expected Investment
• Return Low High Medium Low
• Speed to market Slowing Improving Good Slow
• Government Costs Low High Low High
• Barriers to Entry Rising Lowering Low High

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Hong Kongs 1999 Three-Pronged Reform Programme

• Market reform SEHK and HKFE were demutualized
  and merged to form the HKEx in Mar 2000, listed
  on 27 Jun 2000
• Infrastructure reform fully electronic
  web-friendly world-class high tech infrastructure
  by 2002/2003
• Legislative reform Securities and Futures
  Ordinance passed in 2001
• Complete Corporate Governance and Enforcement
  overhaul 2001-2005

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Hong Kong Largest Market in Asia ex-Japan,
1988-2006 (US bn)
Remark x increase from end 1988 to end Mar
2006 Sources WFE and IFC
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Capitalization and Turnover of Major Markets(end
Mar 2006, US bn)
Remarks Turnover - for the 12 months ending Mar
2006, P/E ratio - end Mar 2006 Due to different
reporting rules calculation methods, turnover
figures are not entirely comparable P/E ratio
for China is the weighted average of A and B
shares markets Sources WFE and websites of
various exchanges
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Financial Sector Masterplan (FSMP)

• A 10-year plan (2001 2010) outlining strategic
  focus actions, with 119 recommendations and
  encompassing 6 sectors
• Banking
• Insurance
• Islamic Banking and Takaful
• Objectives
• Create a more efficient (services at lowest
  cost), effective (broad range of services)
• stable (minimal systemic risks) financial
  system
• Meet socio-economic agenda in an effective
  efficient manner
• Meet international commitments prepare domestic
  financial institutions for global competition
• Implementation Phases
• Phase I (3 years)
• - Enhance capacity of domestic institutions to
  compete
• - Enhance financial infrastructure
• Phase II (3-4 years)
• - Intensify competitive pressure in the
  domestic financial sector
• - Level playing field with incumbent foreign
  banks
• Phase III (after 7 years)
• - Assimilate into global arena
• - Introduce new foreign competition

• Development Financial Institutions
• Labuan IOFC
• Alternative Modes of Financing

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Capital Market Masterplan (CMP)

• A 10-year plan (2001 2010) outlining strategic
  focus actions, with 152 recommendations to
  address 4 key Malaysian capital market
  challenges
• Lingering effects of the regional financial
  crisis
• Meeting the needs of a growing economy
• Heightened global competition for business and
  investment
• Changing demands on the regulatory framework and
  authorities
• Objectives
• To be the preferred fund-raising center for
  Malaysian companies
• To promote an effective investment management
  industry and a more conducive environment for
  investors
• To enhance the competitive position and
  efficiency of market institutions
• To develop a strong and competitive environment
  for intermediation services
• To ensure a stronger and more facilitative
  regulatory regime
• To establish Malaysia as an international Islamic
  capital market centre
• Implementation Phases
• Phase I (3 years)
• Strengthen domestic capacity, and develop
  strategic and nascent sectors
• Phase II (2 years)
• Further strengthen key sectors and gradually
  liberalise market access
• Phase III (5 years)

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Global Competitiveness Malaysias Standing
Countries IMD Ranking1 IMD Ranking1 WEF Ranking2 WEF Ranking2
Countries 2005 2004 2005 2004
United States 1 1 2 2
Hong Kong 2 6 28 21
Singapore 3 2 6 7
Australia 9 4 10 14
Taiwan 11 12 5 4
Japan 21 23 12 9
Malaysia 28 16 24 31
Korea, Rep. 29 35 17 29
Thailand 27 29 36 34
Indonesia 59 58 74 69
Source World Economic Forum (WEF), 2005/06
Institute for Management Development (IMD),
2005 1 IMD World Competitiveness Ranking 2 WEF
Growth Competitiveness Index Ranking
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Malaysias Competitiveness Trend
Category IMD World Competitiveness Ranking IMD World Competitiveness Ranking IMD World Competitiveness Ranking IMD World Competitiveness Ranking IMD World Competitiveness Ranking
Category 2001 2002 2003 2004 2005
Economic Performance 9 29 25 16 8
Government Efficiency 24 19 14 16 26
Business Efficiency 31 24 18 13 25
Infrastructure 35 31 31 30 34
Overall 28 24 21 16 28
Source Institute for Management Development
(IMD), 2005
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Global Competitiveness Government Efficiency
Perspective
Countries Public Finance Public Finance Public Finance Public Finance
Countries Employment in Public Sector Government Budget General Govt. Expenditure Collected Total Tax Revenues
United States 23 40 29 21
Hong Kong 9 12 10 4
Singapore 1 19 15 10
Taiwan 13 37 16 9
Japan 2 54 18 24
Malaysia 15 46 22 15
Korea, Rep. 2 14 17 23
Thailand 11 16 3 13
Indonesia 17 26 8 7
Source Institute for Management Development
(IMD), 2005
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Global Competitiveness Government Efficiency
Perspective
Countries Institutional Framework Institutional Framework Institutional Framework Institutional Framework Institutional Framework
Countries Government Decision Transparency Public Service Bureaucracy Bribing and Corruption
United States 16 18 19 23 20
Hong Kong 47 25 9 5 9
Singapore 1 3 12 1 6
Taiwan 30 33 10 9 29
Japan 41 51 30 28 28
Malaysia 22 22 24 25 36
Korea, Rep. 33 34 20 22 33
Thailand 5 32 28 16 44
Indonesia 55 56 47 51 55
Source Institute for Management Development
(IMD), 2005
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Global Competitiveness Government Efficiency
Perspective
Countries Openness Openness Openness Openness Openness
Countries Protectionism Public Sector Contracts International Transactions Foreign Investors Access to Capital Market
United States 26 28 31 15 9
Hong Kong 1 4 1 1 1
Singapore 7 11 13 23 15
Taiwan 31 33 35 43 34
Japan 43 58 43 50 36
Malaysia 50 53 44 54 47
Korea, Rep. 35 39 38 37 35
Thailand 42 27 42 53 40
Indonesia 57 47 49 52 50
Source Institute for Management Development
(IMD), 2005
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Global Competitiveness Government Efficiency
Perspective
Countries Competition and Regulations Competition and Regulations Competition and Regulations Competition and Regulations Competition and Regulations
Countries Government Subsidies Subsidies Price Controls Regulation Intensity Ease of Doing Business
United States 13 33 16 23 4
Hong Kong 1 2 4 1 1
Singapore 3 4 24 5 2
Taiwan 15 16 27 18 8
Japan 21 46 31 21 30
Malaysia 17 37 53 22 17
Korea, Rep. 4 13 51 45 45
Thailand 19 19 44 30 19
Indonesia 33 56 57 51 54
Source Institute for Management Development
(IMD), 2005
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Malaysias Competitiveness Disadvantages
WEF Growth Competitiveness Index Rank WEF Business Competitiveness Index Rank WEF Growth Competitiveness Index Rank WEF Business Competitiveness Index Rank WEF Growth Competitiveness Index Rank WEF Business Competitiveness Index Rank WEF Growth Competitiveness Index Rank WEF Business Competitiveness Index Rank 24 23
Notable Competitiveness Disadvantages (position out of 117 countries) Notable Competitiveness Disadvantages (position out of 117 countries) Notable Competitiveness Disadvantages (position out of 117 countries) Notable Competitiveness Disadvantages (position out of 117 countries) Notable Competitiveness Disadvantages (position out of 117 countries)
Macroeconomic Environment Government surplus/deficit 96 Government debt 49 Public Institutions Irregular payments in public utilities 47 Irregular payments in exports imports 45 Irregular payments in tax collection 36 Organised crime 31 Technology Gross Tertiary enrolment 63 Telephone lines 61 Company Operations and Strategy Nature of competitive advantage 54 National Business Environment Extent of bureaucratic red tape 101 Centralisation of economic policymaking 80 Others Freedom of press 83 Telephone/fax infrastructure quality 45 Prevalence of trade barriers 38 Informal Sector 37 Reliability of police services 37 Foreign ownership restrictions 37 Company Operations and Strategy Nature of competitive advantage 54 National Business Environment Extent of bureaucratic red tape 101 Centralisation of economic policymaking 80 Others Freedom of press 83 Telephone/fax infrastructure quality 45 Prevalence of trade barriers 38 Informal Sector 37 Reliability of police services 37 Foreign ownership restrictions 37
Source World Economic Forum (WEF), 2005/06
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Global Competitiveness Stock Market Perspective
Countries Stock Markets Financing Capitalisation Capitalisation Value Traded (US per capita) Listed Domestic Companies Stock Market Index
Countries Stock Markets Financing (US bn) ( of GDP) Value Traded (US per capita) Listed Domestic Companies Stock Market Index
United States 2 1 10 2 2 53
Hong Kong 1 9 1 3 10 40
Singapore 13 27 5 14 16 38
Taiwan 15 15 9 10 14 56
Japan 31 2 25 16 5 52
Malaysia 25 26 3 34 11 39
Korea, Rep. 37 16 31 23 7 47
Thailand 17 33 21 35 18 58
Indonesia 39 42 51 56 21 12
Source Institute for Management Development
(IMD), 2005
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Global Competitiveness Stock Market Perspective
Countries Share-holders Rights Financial Institutions Transparency Cash Flow Corporate Debt Factor-ing Adaptability of Companies Ethical Practices
United States 10 16 9 11 27 7 15
Hong Kong 25 8 1 1 21 1 16
Singapore 23 13 4 6 35 13 28
Taiwan 48 32 7 21 1 3 22
Japan 54 49 20 33 41 35 29
Malaysia 34 40 34 40 51 25 31
Korea, Rep. 46 35 28 35 53 24 36
Thailand 39 30 21 32 50 32 34
Indonesia 51 51 53 55 54 59 60
Source Institute for Management Development
(IMD), 2005
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World Bank Doing Business Global Index
Country Start business no. of procedures Getting licence (days) Cost of license ( of income per capita Registering Property (days)
Singapore 3 129 24 9
Australia 2 121 12.3 32
Hong Kong 5 230 38.5 83
Korea 12 60 232.6 11
Thailand 8 147 17.3 2
China 13 363 126 32
Taiwan 8 235 250.9 5

Malaysia 9 226 82.7 143
Source World Bank, 2006
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Bottom Line Malaysia already has the Plans HR
Infrastructure to be IFC

• Its not about Vision, Mission or Infrastructure
• Advantage 1 We have spent RM3 billion and 10
  years to make Labuan a viable Offshore Financial
  Centre
• Advantage 2 KL has the lifestyle and
  infrastructure to be attractive Asset Management
  Centre for Asia
• Advantage 3 Malaysia is already leading Islamic
  Banking Centre
• Advantage 4 Over 15,000 Malaysian professionals
  in Hong Kong alone, excluding Singapore and
  elsewhere - global talent is recruitable
• Advantage 5 Malaysian costs are lower than
  other regional financial centres.
• EXECUTION and IMPLEMENTATION is key to success.

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Finance is not a zero-sum game in Asia. Malaysia
can offer niche services at lower costs

• Malaysia can be Global Islamic Financial Centre -
  watch the competition.
• KL can be Asset Management Centre for Asia -
  Labuan is already booking centre.
• We can be outsource subcontractors in accounting,
  secretarial, cartoons, sound, film, book
  production etc to high cost centres.
• Need focused implementation and constant
  benchmarking to international standards, plus
  partners from all over the world.
• Outsourcing and Services business needs
  widespread and stable broadband.

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Development and Growth is a Process To have
Sustainable Growth, you need a Process to Manage
Development Process

• Development is complex, because those who face
  most problems are those who are closest to the
  problem the poor, SMEs, private sector, grass
  root public servants.
• Its not about QUANTITY OF GROWTH, BUT QUALITY.
• In the past, development has been top-down. Aid,
  not trade. Today, we understand that we have to
  use market forces to lead growth.
• Therefore, the key to sustainable growth is to
  have inclusive, transparent and accountable
  processes to manage the growth process.
• This is a co-operative venture, not
  public-private competition. This includes using
  national global talent and skills.

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ABC of Knowledge Economy

• ACADEMIA - Holders of Knowledge, but bogged down
  in teaching. Segmented from market or government
• BUSINESS - Close to market, but do not use
  Academia for RD and sees Civil Service as
  hindrance rather than partner
• CIVIL SERVICE - Holder of massive public
  information and resources that can help growth.
  Currently, rarely uses Academia for RD and
  policy work. Focuses more on regulation rather
  than BUSINESS facilitation.
• Competing internationally means that
  transactions costs of doing business and time to
  market in Malaysia must come down. Its all
  about teamwork. We have to operate as truly
  Malaysia Inc.

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Change Management is Tough

• Clarity of Role and Objectives
• Rules have no meaning unless they are enforced
• Its the outdated processes that must change
• Prioritization of Doables
• Getting staff and public buy-in
• The whole world is adjusting - pain is inevitable
• Deliver small winners to achieve credibility -
  the big winners will take care of themselves

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Focus and Prioritize
Pick important problems and fix them and tell
everyone.. The essence of the regulatory
craft lies in picking the right tools for the
job, knowing when to use them in combination, and
having a system for recognizing when the tools
are inadequate so that new ones can be
invented. Professor Malcolm Sparrow, The
Regulatory Craft, Harvard University.
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Fixing the Problem

• Old-style regulators
• Nitpicking, unreasonable, unnecessarily
• adversarial, rigidly bureaucratic, and
• incapable of applying discretion sensibly.
• It is often the obsolete and defective
  systems, not the people, that create
  problems.
• Change is the constant. Be prepared to
• change.

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Enforcement of Laws, not Laws per se, is critical
OECD - Too often, legislators issue laws as
symbolic public action, rather than as practical
solutions to real problems. Regulatory inflation
erodes the effectiveness of all regulations,
disproportionately hurts small and medium
businesses, and expands scope for misuse of
administrative discretion and corruption.
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Implications for Johore

• Johore has huge advantage by being next to
  Singapore, which is already an IFC.
• Key is connectivity reduction of friction costs
  to and from JB - Singapore. Stable broadband
  enables outsourcing from Singapore to Johore.
• In RMK9, notice that MRT is being considered.
  Can MRT link to Singapore be considered to enable
  flow of people and ICT pipes?

44
Implementation of 9th Plan will focus on Southern
Johor Economic Region

• RM12.2 bn allocated to develop SJER, building up
  Nusajaya, Danga Bay waterfront, a transport hub
  and high speed rail link from JB to Kuala Lumpur.
• 6,480 ha of land will be developed in Nusajaya,
  housing Johors new administrative centre,
  universities, theme park and industrial/residentia
  l estates
• Logistic hub will include Tanjung Pelepas, Senai
  Airport and Pasir Gudang.

45
FIRST CLASS SERVICE

• As small open economy, Malaysia has already
  reached Middle-Income Status. We are caught in
  middle bulge. Not big enough to have economies
  of scale, but not too small to be marginalized.
• Korea learnt key lesson from Asian crisis the
  governance structure of DEVELOPED COUNTRY status
  is very different from EMERGING MARKET status.
  Korea paid for this lesson.
• Go for quality of service, not quantity. Go for
  value, not size. Quality of governance at both
  public and private sector key to success.
• To reach 2020 DEVELOPED economy status, we are
  already benchmarked against global standards.

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• Thank you
• Questions to as_at_andrewsheng.net